When buying a leasehold property, purchasers will usually be advised to consider the annual service charge. However, part of that service charge may be collected and set aside for future expenditure rather than spent on the building’s immediate running costs.
This money is commonly referred to as a “reserve fund” or “sinking fund”. Understanding how the fund operates, how much it contains and what it may be used for can help buyers assess the likely future costs of owning a leasehold property.
What Is a Reserve Fund or Sinking Fund?
A reserve fund, sometimes called a sinking fund, is money collected from leaseholders through the service charge and set aside for future major works. The terms are often used interchangeably, but the lease should be checked to confirm how contributions may be collected and spent.
What Can the Fund Be Used For?
Reserve funds are generally used for major or non-routine works that may only be required every few years. Depending on the building and the terms of the lease, the fund may be used for:
- roof repairs or replacement;
- internal or external redecoration;
- structural repairs;
- replacement of communal carpets;
- lift repairs or replacement;
- replacement of communal boilers or heating systems; and
- other major works affecting the building or estate.
Day-to-day costs, such as cleaning, gardening, buildings insurance and management fees, are normally paid from the annual service charge budget.
Does Every Leasehold Building Have a Fund?
Not every leasehold development has a reserve or sinking fund. Contributions can generally be collected only where the lease permits them, and the lease should explain how the fund may be used.
The lease may specify the annual contribution or allow the landlord or managing agent to determine a reasonable amount based on anticipated future expenditure and the amount already held. The contribution will therefore vary between developments.
Where major works are proposed, the landlord may be required to consult leaseholders under the statutory Section 20 procedure, even where some or all of the cost will be paid from the reserve fund.
What Are the Benefits of a Reserve Fund?
A properly managed reserve fund can help spread the cost of major works across a number of years.
Without a reserve fund, leaseholders may face a substantial one-off service charge demand when major repairs or replacement works are required. A reserve fund helps spread these costs over time and makes future expenditure easier to plan for.
However, the existence of a reserve fund does not guarantee that all future works will be fully covered.
For example, if major roof repairs are expected to cost £100,000 but the reserve fund contains only £60,000, the leaseholders may still be required to contribute towards the £40,000 shortfall through an additional service charge demand.
How Is the Fund Held and What Happens on Sale?
For private-sector leasehold properties, reserve fund contributions must generally be held on trust for the benefit of the leaseholders and kept separately from the landlord’s own money. The fund may only be used for purposes permitted by the lease, and any interest earned will usually be added to the fund.
Leaseholders may be entitled to request information about the fund, including contributions received, expenditure and the remaining balance.
When a leaseholder sells the property, they will not usually receive a refund of their contributions unless the lease provides otherwise. The money normally remains in the fund for the future maintenance of the building, with the incoming buyer benefiting from the existing balance.
What Should a Buyer Check?
As part of the conveyancing process, the buyer’s solicitor or conveyancer should review the lease, service charge accounts and information provided by the landlord or managing agent.
Key points include:
- whether the lease allows reserve fund contributions;
- the current balance and annual contribution;
- any recent expenditure from the fund;
- whether major works are planned;
- whether the fund is likely to cover those works; and
- whether additional payments may be required.
A low service charge is not always beneficial if little or no money is being set aside for future major works. Equally, a higher service charge may reflect responsible long-term planning.
Conclusion
Reserve and sinking funds can help spread the cost of major works and reduce the risk of unexpected service charge demands. Buyers should carefully review the lease, the amount held and any planned works before proceeding with a leasehold purchase.
Our experienced conveyancing solicitors can guide you through each stage of the transaction, explain the relevant leasehold information clearly and advise on any potential concerns. We assist clients in English, Mandarin and Cantonese.